Star Corporation is a provider of computer software and IT services in two large regions of Easter Europe. The company uses 12 percent to evaluate investments; however, due to latest developments it realized that two divisions have quite different risks and returns. In fact, comparable companies for region 1 have equity betas of 2.0 while in region 2 this is about 0.5. The financial manager aims to estimate the cost of capital as close to correct as possible and tries to evaluate how acceptable investments in both regions are at 12 percent rate.

The following data is available for both divisions:

a. Estimate WACC for both divisions.

b. How acceptable is the investment at 12 percent? In general, Star Corporation used 11 percent as a cost of capital. Do you think that this appropriate? Why or why not?

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Equity beta Tax rate Cost of debt Debt ratio Risk-free rate of interest Market risk premium DIVISION 1 (%) 2 20 6 5 4.5 DIVISION 2 (%) 0.5 20 11 45